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Chinese lessons

2010-06-07: China Education (CEU.NYSE) has great assets, positive cash flow, good management and dramatic growth. Why is the stock languishing? China Education offers online education and on-site training, plus a database of exams and test papers for all levels from primary to college. It specializes in preparing secondary school students for the country’s infamous college entrance examination.

The company estimates that nine million students sit the test each year, competing for just three million places. There are certain private schools in Beijing and Shanghai where the pass rate is higher than 90%, and China Education records lectures from teachers at those schools and puts them online. This affords all students the opportunity to learn from the best teachers.

The services are sold with a debit card, which means that as the company needs little in the way of working capital as it grows revenues.

China Education, founded in northeastern China in 2004, listed on the New York Stock Exchange in January after a few years with OTC and Amex. It posted a 49% increase in revenue to US$37 million in the 2009 fiscal in fiscal; gross margins remained stable at around 80% for both 2008 and 2009.

Most importantly, the company’s net income rose 50% to US$15 million – and it delivered a net income margin of 41%. These financials represent the power of a web-based business, with minimal working capital requirements. Google by comparison has net income margins of 29%.

China Education operates two language training centers in Beijing. An official at the center told SinoSage that all teachers are foreigners and the maximum class size is 10. Efforts are being made to diversify product offerings, notably through the development of an online educational game recommended and approved by the Ministry of Education.

The company has also made several acquisitions of other China education or training companies, primarily with share swaps, which puts little pressure on cash flow.

China Education’s net cash position as of March 31, 2010 was US$68 million, up from US$65 million at the end of December 2009. The company has 31.4 million shares outstanding which means the business has cash per share of US$2.18. Its ability to generate cash is unusual for a growth company.

China Education is currently trading at US$4.31; back out the cash and you would be investing at US$2.13. The company earned US$0.56 per share over the last 12 months, so you’re buying a business that grows net income at 50% per year for 3.8 times earnings net of cash.

SinoSage believes China Education should trade for at least 15 times earnings, based upon the multiples given to other Chinese education companies. The stock has been dragged down by overall stock market trends from its peak of US$7.37, but the business just keeps getting better and better.

There is no reason why the stock shouldn’t hit US$8.50.